There are two kinds of LLC: those managed by all of the members equally, and those managed either by one or more members, or by a third party individual or business structure. When you’re trying to determine which one is better for you, the crucial issue to consider is control.
The choice of making your LLC member-managed or manager-managed has no bearing on the LLC’s tax election. It doesn’t matter if you’re planning to elect C or S Corporation taxation, or stick with the default flow-through – the issue is control: WHO can direct the LLC’s daily business.
A member-managed LLC is operated equally by all of its members. That means that everyone is expected to share equally in business decisions and the day-to-day operations of the entity. Alternatively, you can select a group of members to become the managing members, and let those members manage by committee.
A member-managed LLC is a great choice if you’re a single owner business, and you don’t anticipate every having people come in as silent, non-participating members. It can also work for a multiple-owner business, again as long as everyone is prepared to participate equally, and you don’t anticipate bringing in non-participating investors.
A member-managed LLC is also a great choice for singles or couples who are using the structure for passive income activities, and who aren’t as concerned about estate-planning and ownership succession as others may be. For a single person with no children, there isn’t really a huge need to create a control transfer mechanism. And for couples, the member-managed entity allows for truly shared control between the spouses. If a spouse is injured or ill and unable to communicate, the other spouse can still continue the LLC’s business.
A manager-managed LLC is a two-level structure. One level provides the management for the LLC (hence the name managers) while the other level is made up of passive members. Essentially you’re creating a de facto limited partnership, without the liability that normally attaches to the general partner. You can have as many managers as you choose, and they can be individuals or other business structures. Managers don’t even have to be members, although in most cases they will be.
It makes sense to operate as a manager-managed LLC if you have a situation where some members are not interested in the hands-on management of the structure, but prefer a more passive role. It’s also great for estate planning. By naming your kids as members, you can bring them into the LLC using IRS gifting allowances, while still retaining control of the LLC.
Special Considerations for Real Estate Professionals
If you claim real estate professional classification on your tax return and have a manager-managed LLC, you must be an active participant in the management and operation of the LLC. That means you’ve got to be named as a manager. In a manager-managed LLC, the members who aren’t also managers are considered passive – just as they would be in a limited partnership. If you make a mistake with your planning here you could set yourself up for an IRS challenge.
On the other hand, you could set up your LLC as a member-managed LLC instead. That way, every member is considered to be actively participating. It’s a great way to strengthen everyone’s argument that they are entitled to deduct all of the available real estate losses.
Can You Change an Existing LLC?
If you have started with one kind of LLC but realize that you really need the other, you can fix it. In most cases, all you will need to do is file an Amendment to the Articles of Organization, noting the change from one to the other, and making any changes to the members or managers listed.
Remember though, that most LLC Operating Agreements require a members vote to make significant changes to the LLC, and this definitely qualifies! So you’ll need to draw up a set of Consent Resolutions and have all of the members sign, or hold a formal meeting and have the members vote on the issue. You’ll also have to change your Operating Agreement to account for the change.
Depending on where your LLC is formed, change can cost a little or a lot. In Arizona and New York, for example, you’ll have to re-publish the Amended Articles in a local newspaper, following the state requirements. That can add a few hundred dollars (in the case of Arizona) all the way up to a few thousand dollars (NY LLC in the 5 boroughs area). So, if at all possible, make sure you plan and set your LLC up properly in the very beginning.